Volatility spikes as government yields plummet

A sharp decline. Followed by a strong intra-day rally. Another big down session.

Volatility is spiking across the board – despite a ‘flattish’ trend where many instruments are still trading within their recent ranges. The S&P 500 VIX Index, for example, is probing its recents highs. This resulted in an interesting base pattern for the iPath S&P Volatility ETF (VXX, see Featured Chart). Normally, high market volatility tends to result in further volatility.

Initially, I expected markets to rebound after Tuesday’s risk-on session. But worse-than-expected economic data from Germany and a further inversion of the yield curve spooked investors. This negates some of Tuesday’s bullishness.

According to some data, the entire Germany yield curve is now negative. This is how fearful investors are in that corner of the market. In addition, Sweden, Eurozone, Denmark, Japan, Switzerland are some other countries that reporting sub-zero policy rates. Meanwhile, the US 10-year Treasury yield is now below 2-year yield for the first time since 2007.

Taken together, it appears credit markets are shouting: ‘Are you ready for a recession?’

Should this recessionary mindset entrench, equity markets will endure more volatility. Back in the UK, the FTSE 100 Index failed to break above 7,300 as expected. Instead, prices slumped all the way to the 7,100 support (see below). A further downside follow-through would smash the key round number level at 7,000. However, given the recent market volatility, I would not be surprised if prices rebound from here.

In times of heightened volatility, either position size should be scaled down or stops tightened, depending on strategies.

 

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